9. Equity Release Products

The equity in your home

Equity is the part of your home that you own outright. If you have no mortgage on your home, you own 100% of the equity. In other words, if you sold your home, all the money from the sale would go to you.

The image below shows how your equity increases over time with an ordinary mortgage.

Your equity in an ordinary mortgage

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mortgage /ˈmɔːɡɪdʒ/= a legal agreement by which a bank or similar organization lends you money to buy a house, etc, and you pay the money back over a particular number of years; the sum of money that you borrow

Equity release products

Equity release products let you use the equity in your home while you still live in it. In Australia you might be offered either:

– a reverse mortgage (this is the most common), or

– a home reversion scheme (available in some areas).

These products have some common features:

– They are generally only available if you are aged 60 or over.

– You can qualify for equity release without an income.

– You don’t need to repay any money while you live in your home.

The risks of equity release 

Equity release products can give you benefits, but they also have significant risks:

– They can be difficult to understand.

– They can be relatively expensive compared to other types of loans with regular repayments.

– If you breach certain terms and conditions you may have to sell your home and repay the loan.

– If property values don’t increase as much as you think, or if they fall, you might end up with less money than you expect when you sell your home.

end up (doing sth) = to find yourself in a place or situation that you did not intend or expect to be in

– Your circumstances and financial views might change as you age – if you release too much money now you may find you do not have enough later on.

What is a reverse mortgage? 

A reverse mortgage is currently the most common equity release product in Australia. With a reverse mortgage, you use the equity in your home as security to borrow money. You can take the loan as a lump sum, in a regular income stream, as a line of credit, or as a combination of these options.

security [uncountablecountable] = a valuable item, such as a house, that you agree to give to somebody if you are unable to pay back the money that you have borrowed from them

A lump sum/lump sum payment = an amount of money that is paid at one time and not on separate occasions

A line of credit = An arrangement between a financial institution, usually a bank, and a customer that establishes a maximum loan balance that the bank will permit the borrower to maintain. The borrower can draw down on the line of credit at any time, as long as he or she does not exceed the maximum set in the agreement

A reverse mortgage is generally only available if you are aged 60 or over. The amount you can borrow is also linked to your age (that is, the older you are, the more you can borrow).

You don’t need to make repayments on the money you borrow while you live in your home. But you must repay the loan in full if you sell your home or die and, in most cases, if you move into aged care.

in full = including the whole of sth

The money you owe increases over time. Fees and interest are added to the loan balance as you go, and the interest compounds. This means you pay interest on the interest, plus interest on any fees or charges added to the loan balance.

The image below shows how your equity decreases over time with a reverse mortgage.

A reverse mortgage

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With compound interest, the amount you owe increases more quickly after the first 10 years.

Compound interest = interest added to the principal of a deposit or loan so that the added interest also earns interest from then on. This addition of interest to the principal is called compounding.

The graph below shows how compound interest and fees could increase a loan of $50,000 to $232,000 over 15 years or $1,041,000 over 30 years. Keep in mind that the value of your property is also likely to change over this period.

What you will owe on a $50,000 loan over 30 years

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How much will it cost you?

How much a reverse mortgage costs you in the end depends on:

– how much you borrowed at the start (the principal)

– how long you have the loan for (the term of the loan)

– whether you receive your loan as a lump sum, a regular income stream, or a line of credit (the loan structure)

– the interest and fees you pay on the loan

– whether you borrow any more money

– whether you have a No Negative Equity Guarantee (NNEG).

No Negative Equity Guarantee (NNEG)

Because of compound interest and fees (and not making any repayments), the amount you owe on a reverse mortgage can grow very quickly.

What you owe can end up being more than the value of your home. If this happens, you have ‘negative equity’ in your home (that is, you owe more than your home is worth). The image below shows how you could end up owing more than your home is worth over time.

Negative Equity

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Most reverse mortgages protect you against negative equity by putting a limit on how much you can owe with a No Negative Equity Guarantee (NNEG).

NNEGs can be lost for a serious breach of the terms and conditions of your loan (for example, wilful damage to your home). In some cases, your protection could be lost for a minor breach of the terms and conditions, so check the fine print: see page 36. The image below shows how a NNEG can protect you against negative equity.

No Negative Equity Guarantee (NNEG)5

What is a home reversion scheme? 

Home reversion schemes are currently only available if you are aged 60 or over and live in certain areas in Sydney or Melbourne.

With a home reversion scheme, you sell a proportion of the equity in your home (for example, up to 65%) while you still live there. You receive a lump sum payment in exchange for a fixed proportion of the future value of your home.

This is different from a reverse mortgage, which is a loan. With a home reversion product, the proportion of the future value of your home that you sell now belongs to the scheme provider. But it is only paid to them when your home is sold (for example, if you move into aged care or die).

The lump sum you receive upfront is reduced or ‘discounted’ to reflect your age and life expectancy. This is because those factors will determine when, and how much, the scheme provider receives for their share of the future value of your home.

life expectancy = the number of years that a person is likely to live; the length of time that something is likely to exist or continue for

Because you can only sell a fixed proportion of the future value of your home, the remaining proportion of your home equity is protected. Whatever is left over after the scheme provider receives their amount will go to you, or to your estate. The image below shows how a home reversion scheme works.

Home reversion scheme

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How much will it cost you? 

How much a home reversion scheme costs you in the end depends on:

– the proportion of home equity you sell

– how much money you get for it (the discounted lump sum you receive)

– how long you live in your home

– how much your home is eventually sold for.

For both reverse mortgages and home reversion schemes, the value of your remaining home equity depends on what your home is worth (and this can rise or fall in value).

If property values don’t increase as much as you have assumed, or if they fall, you might end up with less money than you expect when you sell your home. In the worst case scenario (if you take out a reverse mortgage that does not have a No Negative Equity Guarantee), you might be left owing more than the value of your home.

So, if you decide to get an equity release product, be conservative in your assumptions about housing values when you are planning how much equity you want to access.

Source: http://www.investors.asn.au/assets/resources/education/borrowing/thinking-about-using-the-equity-in-your-home.pdf

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